The Downside to F.H.A. Loans

Mortgages insured by the Federal Housing Administration are the go-to product for borrowers who don’t have much cash for a down payment. But the required mortgage insurance premiums have become so costly that some critics argue that the agency is taking advantage of borrowers who have few other options.

One of the most vocal critics is Edward J. Pinto, a resident fellow of the American Enterprise Institute, who calls the terms “predatory” and “abusive.” He argues that the majority of F.H.A. loans are at high risk for default should the economy tip back into recession, but that borrowers have no way of knowing how safe their loans are, because the agency prices all loans the same.

Low-risk borrowers, he said, are overcharged to subsidize those at higher risk. “The consumer who has the very-low-risk loan doesn’t even know he might be better off going through the private sector,” Mr. Pinto said. “They may assume that the government is protecting their interests.”

F.H.A.-backed loans cater to first-time buyers because they require as little as 3.5 percent down. Conventional loans backed by Fannie Mae require a minimum of 5 percent down, as well as private mortgage insurance.

The difference in premiums, depending on the loan type, is considerable. Mark Yecies, an owner of SunQuest Funding, offered an example: On a $300,000 loan with 5 percent down, the F.H.A. would charge an upfront insurance premium of 1.74 percent, or $5,250 financed into the loan. The premium would also add $325 a month; if the borrower put down only 3.5 percent, the premium would be $337.50. In contrast, the same loan with 5 percent down and private mortgage insurance would not charge an upfront fee; the monthly premium would be $175.

Mr. Yecies says that if home buyers have decent credit but are short the 5 percent, he often suggests they ask the seller to pay their closing costs as part of their purchase offer. That way, they can bring more money to the table for a down payment. But “less sophisticated” lenders may automatically usher such borrowers into more costly F.H.A. loans, he said.

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David Stevens, the president of the Mortgage Bankers Association, agrees that borrowers are better off with a Fannie Mae-backed loan if they can put at least 5 percent down and have a minimum FICO score of 740. And F.H.A.’s market share has in fact dropped as its insurance premiums have risen. But Mr. Stevens, who served as F.H.A. commissioner from 2009 to 2011, says Mr. Pinto’s argument that the F.H.A. is preying on the poor simply doesn’t hold up. He acknowledged that its underwriting standards were too lax during the years after the mortgage market collapse, when lenders shifted their volume to F.H.A. loans, drawing borrowers with the worst credit and ending up with high delinquency rates.

But the agency has since tightened its standards — for example, by setting a minimum FICO score of 580 for those putting 3.5 percent down. Its portfolio quality has greatly improved, as shown in a recent Congressional Budget Office study, Mr. Stevens said. “The data clearly shows that the loans being made today by F.H.A. are the highest-quality loans in its history, with extremely low default rates.”

Dr. Michael Lea of the Corky McMillin Center for Real Estate at San Diego State University says that although he doesn’t view the F.H.A. as predatory, borrowers would benefit if the agency shifted to risk-based pricing. And he likes Mr. Pinto’s call for consumer disclosures comparing insurance costs of F.H.A. and Fannie Mae loans.

“I would like to see a little more tightening of the guidelines,” he said, “even if that means less homeownership support.”

A version of this article appears in print on December 8, 2013, on Page RE6 of the New York edition with the headline: The Downside to F.H.A. Loans. Order Reprints|Today's Paper|Subscribe